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Legal update – no setting-off unfair preferences

Legal update – no setting-off unfair preferences

In surveying the myriad of competing case law and theories, Matthew Hudson of our SV Voidables team has published an article in the Australian Restructuring Insolvency & Turnaround Association Journal arguing four possible reasons why set-off should not apply to unfair preference claims. We have provided below a summary of this article, but interested readers are encouraged to click [here] to read the entire article.

Section 588FF of the Corporations Act 2001 (Cth) (the Act), along with a number of associated sections, allows Liquidators to recover transactions that, generally speaking, gives a creditor a benefit, advantage or preference over and above all other creditors at a time when that creditor ought to have reasonably known that the company (now in liquidation) was insolvent. The recovery of these transactions can be a powerful tool for Liquidators and can in a number of circumstances be the only pool of funds that Liquidators may come into possession of during their appointment.

However, the benefit of recovering these transactions has, arguably, been limited by the Queensland District Court decision of Morton v Rexel Electrical Supplies Pty Ltd[2015] QDC 49 (the Rexel case). For those readers not aware, in the Rexel case, Searle DCJ held that the set-off provision in s 553C of the Act applied to reduce the recoverable amount of the unfair preference claim (under s 588FA of the Act). Within the article (which is set out below), an example is given highlighting the significant reduction to the value of claims should the Rexel case be applied universally.

Peak debt during the relation-back period $170,000
  Less POD lodged by the creditor (s 588FA(3)) ($75,000)
  Less POD lodged by the creditor (s 553C(1)) ($75,000)
Recoverable preference $20,000

The four reasons why set-off should not apply

1.The proof of debt would otherwise be deducted from the unfair preference claim twice, insofar as s 588FA(3) of the Act is concerned – As demonstrated by the above example, if set-off was said to apply, the $75,000 debt owing to the creditor would be deducted twice. Firstly, by virtue of the Running Account defence (s 588FA(3)) and secondly by the set-off allowed in ‘Rexel’ (553C).  The article goes on to consider the historical relationship between ss 553C and 588FA(3) of the Act insofar as whether both provisions could work tangentially.

2.Until the appointment of the liquidator, there is no contingent liability that exists at law or otherwise – According to the Australian Accounting Standards (the AASB’s), a ‘contingent liability’ requires an obligating event that can only arise where it can be enforced at law. The article argues that as an unfair preference claim only arises upon the company entering into Liquidation, the contingent liability (being the unfair preference claim) can only arise after the time in which set-off is said to automatically arise.

3.The argument that the legislature intended to create mutuality – Pursuant to s 588FF(1)(a) of the Act, the proceeds from an unfair preference claim are required to be paid to the company. It has been argued that this requirement was the legislature expressing an intention to create ‘mutuality.’ The article considers whether this payment to the company ‘grows in the natural course of events’ (being an important element of set-off), the ‘beneficial ownership’ characterisation by Mr Rory Derham and some practical considerations not fully considered by the Courts to date.

4.The application of s 553C to voidable transactions defeats the objective of Part 5.7B of the Act – The primary purpose of the unfair preference provisions is to promote equality of distribution among creditors. The article argues that this purpose is directly undermined by the application of set-off by allowing a pre-liquidation debt to be set-off against a liquidator’s unfair preference claim.

Takeaway

Before creditors, advisors and practitioners rely too heavily on the Rexel case, it is important to take stock of some important issues not directly addressed in that case, which may otherwise have had a bearing on the decision. Our Expert Advisors will continue to monitor this area of the law and update stakeholders on any future developments.

If you have any questions about the above article, please contact one of our Expert Advisors on 1800 246 801.

 

Article written by Matthew Hudson, Manager, Queensland

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